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The scoop on group audits: You may have them, even though you think you don’t

As Vince Lombardi said, “Individual commitment to a group effort—that
is what makes a team work, a company work, a society work, a
civilization work.” I would add to this that an individual firm’s
commitment to group audit considerations makes audit planning work.

Simply stated, group audits are audits of financial statements that
include the financial information of more than one component. There
seems to be diversity in practice when firms audit financial
statements with multiple components. Group audits are addressed in
AU-C Section 600, Special Considerations—Audits of Group Financial
Statements (Including the Work of Component Auditors). The term
“Special Considerations” can be confusing. AU-C sections with “Special
Considerations” in their title address situations that, while common,
don’t arise in every audit. However, consideration of whether these
standards apply is required in every audit. This article covers
consideration of when the group audit standard applies and how this
can be determined.

When does this standard apply to my audit?

A good place to start is with some preliminary considerations and
definitions of key terms.

Group audit: The audit of group financial statements.

Group financial statements: Group financial
statements are financial statements that include the financial
information of more than one component. “Group financial statements”
also refers to combined financial statements aggregating the
financial information of components that are under common control.

Component: A component is an entity or business
activity for which group or component management prepares financial
information that is required to be included in the group financial
statements. A component may include, but is not limited to,
subsidiaries, geographical locations, divisions, investments,
products or services, functions, processes, or component units of
state or local governments.

I’m auditing everything from soup to nuts, so do the group
audit requirements apply to me?

The key to answering this question is in the definition of group
financial statements. When you audit a set of financial statements
with multiple components, those are group financial statements. Your
firm may be the only firm engaged, but you still have group audit
considerations. It is fairly clear that the group audit standard (AU-C
Section 600) applies when multiple accounting firms are involved in an
audit of multiple entities. Many misinterpret the term “group audit”
to mean: If the audit involves multiple accounting firms, group audit
applies, but if it doesn’t then it isn’t a group audit. This is an
easy mistake to make, since the applicable preclarity auditing
standard, AU 543, Part of Audit Performed by Other Independent
Auditors, focused on who was performing the audit, not what was
being audited. Adding to the confusion, the subtitle of the AU-C 600
section (containing AU-C Sections 600, 610, and 620) is “Using the
Work of Others.” Nevertheless, under the clarified auditing standards,
AU-C Section 600 is applicable to any audit of group
financial statements, even if only one auditor is
involved.

When the component is being audited by the
group engagement team, the group engagement team serves as both the
group auditor and component auditor. In this article, the term “group
auditor” refers both to the “group audit team” and the “group
engagement partner,” even though the standard further differentiates
responsibilities by referring to these parties separately. It is
important to note that the same personnel may, and often do, function
as both members of the group engagement team and a component audit
team. The AICPA’s Technical Practice Aids, TIS Section 8800,
Audits of Group Financial Statements and Work of Others,
tackles group audits. Below are responses to questions about when a
group auditor is also a component auditor.

Section 8800.24: Applicability of AU-C Section 600 When Only
One Engagement Team Is Involved

Inquiry—Company X consolidates the operations of Entity A. The same
group engagement team that audits Company X also audits Entity A.
Because only one engagement team is involved, does AU-C Section 600
apply? If so, what does AU-C Section 600 require that is not already
covered by other auditing standards?

Reply—AU-C Section 600 applies to all audits of group financial
statements, which are financial statements that contain more than
one component. In the circumstances when the same engagement team
audits all components of the group, the considerations addressed in
AU-C Section 600 that relate to component auditors are not relevant.
However, considerations addressed in AU-C Section 600, such as
understanding the components; identifying components that are
significant due to individual financial significance and the
significant risk of material misstatement; determining component
materiality; understanding the consolidation process; and addressing
the risks, including aggregation risk, of material misstatement in
the group financial statements are relevant in all group
audits.[Issue Date: February 2013.]

Section 8800.39: Disaggregation of Account Balances or Classes
of Transactions

Inquiry—Company X consolidates the operations of Entity A. The same
group engagement team audits Company X and the operations of Entity
A; no other auditors or engagement teams are involved. Are there any
requirements in AU-C Section 600 to disaggregate account balances or
classes of transactions for purposes of auditing the consolidated
financial statements of Company X? For example, is the auditor
required to disaggregate accounts receivable for purposes of
confirmation procedures, or can the consolidated group of accounts
be treated as one population?

Reply—AU-C Section 600 does not require the auditor to disaggregate
account balances or classes of transactions. The group auditor
should design an audit plan that is responsive to the risks of
material misstatements to the consolidated financial statements. The
less similar the risks of material misstatement at the group and
component level, the less appropriate it may be to perform audit
procedures for some or all accounts or classes of transactions at
the group level. Additionally, the more complex the group (for
example, decentralized systems, fewer groupwide controls, differing
jurisdictions, or diverse product lines), the less likely that
testing in the aggregate will sufficiently and appropriately address
the risks of material misstatement.[Issue Date: February 2013.]

How do I identify components?

A group audit is an audit of group financial statements, and
financial statements are group financial statements when they contain
the financial information of more than one component. So the first
step in determining whether your audit is a group audit is
consideration of components, including determining whether the
financial statements include the financial information of more than
one component. If so, the audit documentation should include an
analysis of the components in accordance with the standard.

Professional judgment is required to determine if a specific business
activity represents a component under AU-C Section 600. If an entity’s
financial reporting system organizes financial information by
function, product or service, or geographical location for purposes of
external financial reporting, such functions, products or services, or
locations may represent components for purposes of AU-C Section 600.

For example, group management may use financial information for
several locations that is aggregated using a separate system or
process from that used to prepare the group financial statements. The
group engagement team may identify the locations as components.
Alternatively, when financial information about a function, product or
service, or geographical location is first part of the group’s
financial reporting system and then disaggregated by group management
for operating purposes, the group engagement team may consider such
financial information in whole or in part as a class of transactions
rather than components.

Financial information classified by business activity for the group
financial statements may represent the operations of a single legal
entity or a number of legal entities. In such cases, the group
engagement team may determine the component to be the business
activity rather than the separate legal entities generating the activity.

The financial statements are group financial statements, and thus the
group audit standard applies if you answer yes to any of the questions
below.

Do the financial statements include one or more of the following?

Consolidated subsidiary.

Entity combined because it is under common control.

Consolidated affiliate (e.g., a variable-interest entity).

Investment accounted for using the equity method of accounting.

Investment in a joint venture.

Investment accounted for using the cost method of accounting,
where the work and reports of other auditors constitute a major
element of evidence for the investment.

Entity consisting of a head office and one or more divisions or
branches, where the divisions or branches are separately managed and
provide separate financial reporting to the head office.

Entity where a separate function, process, product or service, or
geographic location is separately managed and provides separate
financial reporting to the head office.

Any other grouping that would constitute a component for financial
reporting purposes.

What are some items that are not components?

The AICPA’s Technical Practice Aids, TIS Section 8800, Audits of
Group Financial Statements and Work of Others, also address
items that are not components, including the following response:

Section 8800.36: Investments Held in a Financial Institution
Presented at Cost or Fair Value

Inquiry—Paragraph .11 of AU-C Section 600 defines a component as
“[a]n entity or business activity for which group or component
management prepares financial information that is required by the
applicable financial reporting framework to be included in the group
financial statements.” Is an investment in a certificate of deposit
or other types of cash investments held by a financial institution
(for example, an overnight repurchase agreement) deemed a component
for purposes of AU-C Section 600?

Reply—No. A certificate of deposit or other cash investments held
by a financial institution or bank do not constitute components.

In addition to investments measured at fair value, inventory and
company shares held by an employee stock ownership plan are examples
of items that are not considered components.

OK, the group audit standard applies. Now what?

After identifying the components in the audit of group financial
statements, the group engagement team is required to determine if any
of these components represent significant components. The group
engagement team makes this determination based on whether the
component is (a) of individual financial significance to the group or
(b) likely to include significant risks of material misstatement (due
to its specific nature or circumstances) of the group financial statements.

During planning, the group engagement team should gain further
understanding of the group, its components, and their environments to
enable them to identify components that are likely to be significant.
Think about the structure of the group financial reporting system.
This knowledge and understanding can be obtained by the group
engagement team as part of its risk assessment procedures when the
team gains an understanding of the entity and its environment.

Significant components identified may result in the group engagement
team’s spending more time performing risk assessment or further audit
procedures than in the years prior to the group audit requirements.
Paragraphs .A6–.A8 of AU-C Section 600 discuss ways the group
engagement team may identify components that are significant. One way
is to apply a percentage to a selected benchmark, such as group
assets, liabilities, cash flows, revenues, expenditures, or net
income, in order to determine components that are individually
financially significant. However, the group engagement team may
determine that other methods or benchmarks are more appropriate based
on the type of group entity or additional facts and circumstances.

In addition, components with complex transactions from a business or
accounting perspective may be identified as specific significant risks
by the group engagement team. For example, a component could include
significant risk from a business perspective if it is subject to
regulation by a government agency, it produces products or conducts
activities of a highly technical nature, or it transacts business with
a governmental entity that is subject to public records laws.
Significant risk from an accounting perspective can arise from complex
related-party relationships, foreign currency or derivative
transactions, or fair value measurements and disclosures, as well as
other relationships or transactions.

If a component is clearly insignificant based on lack of financial
significance to the group or a low risk of material misstatement of
the group financial statements, then further consideration may not be
deemed necessary at the component level. However, at a minimum, AU-C
Section 600 requires the group engagement team to perform analytical
procedures at the group level for any components that are not
significant components.

Identification of a group audit is critical

As explained, the most critical first step in a group audit
engagement is identifying that the engagement is a group audit. After
that, applying the risk assessment standards in a group audit means
that the auditor considers what could go wrong at the component level
so that an audit can be properly planned and performed to obtain
reasonable assurance that the group financial statements are free from
material misstatement. These are critical first steps to properly
planning a group audit. The resources listed below are available to
assist in applying this guidance as well as the rest of the standard.

—Michael A. Westervelt is a partner in the National
Assurance Technical Group of CliftonLarsonAllen LLP and a member of
the AICPA PCPS Technical Issues Committee.

AU-C Section 600, Special Considerations—Audits of Group
Financial Statements (Including the Work of Component
Auditors), AICPA Professional Standards, as of June 1,
2013 (Volume 1) (#APS13P, paperback; #WPS-XX, online subscription)

Understanding the Responsibilities of Auditors for Audits of
Group Financial Statements, AICPA Audit Risk Alert, 2013
(Appendix A of this publication also includes Technical Practice
Aids 8800.01-.41 issued through March 2013) (#ARAGRP13P,
paperback; #ARAGRPO, one-year online subscription; and #ARAGRP13E, ebook)